McGlothlin v. Comm'r of Internal Revenue (In re Estate of McGlothlin), Docket No. 5567-63.

• Decision Date: 22 July 1965
• Docket Number: Docket No. 5567-63.
• Citation: 44 T.C. 611
• Parties: ESTATE OF EVELYN McGLOTHLIN, DECEASED, RAY McGLOTHLIN, JR., EXECUTOR, AND RAY McGLOTHLIN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

44 T.C. 611

ESTATE OF EVELYN McGLOTHLIN, DECEASED, RAY McGLOTHLIN, JR., EXECUTOR, AND RAY McGLOTHLIN, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5567-63.

Tax Court of the United States.

Filed July 22, 1965.

Ronald M.Mankoff, Wentworth T. Durant, and Robert E. Davis, for the petitioners.

R. A. Roberts, for the respondent.

Petitioner was the principal shareholder of P corporation. As a part of a merger whereby T corporation would acquire the stock of P corporation, petitioner executed a ‘guaranty agreement’ undertaking to guarantee the $1,098,414.14 market value of three ranch properties owned by P corporation. when T corporation was unable to sell the properties, petitioner performed on his obligation and expended $261,968.74 to acquire the properties personally. Held: The payment of $261,968.74 did not constitute a deductible loss under section 165(c)(2), I.R.C. 1954. The transaction was not entered into for profit, since petitioner's prime motive for executing the guaranty agreement was to acquire T corporation stock, and he could at best hope that he would not sustain a loss in the transaction. Held, further, the proper method for reflecting the payment is to adjust the cost basis of T corporation stock which was also sold by petitioner in the same taxable year.

TRAIN, Judge:

Respondent determined a deficiency in petitioners' income tax for the taxable year ended May 31, 1959, in the amount of $218,990.05. Petitioners' initial objection that respondent's action is barred by the statute of limitations was conceded by them in the reply brief. The parties agree that the only issue remaining for decision is whether a payment by petitioner Ray McGlothlin of the sum of $261,968.74 to Texas Calgary Co. during the taxable year in question gave rise to a deductible loss under section 165(c-(2), I.R.C. 1954.

FINDINGS OF FACT

A stipulation of facts, and the exhibits attached thereto, are incorporated herein by this reference.

Ray McGlothlin (sometimes hereinafter referred to as petitioner) and Evelyn McGlothlin were husband and wife and, during the period here involved, resided at Abilene, Tex. On November 13, 1959, they filed a joint Federal income tax return, on the cash method of accounting, with the district director of internal revenue at Dallas, Tex.

Evelyn McGlothlin passed away on September 19, 1964, and Ray McGlothlin, Jr., having duly qualified as executor, was substituted as a party.

Petitioner worked in the oil industry from the age of 17, digging ditches, mixing concrete, and cutting pipe; in 1934, he went into the oil business in Goldsboro, Tex.

Petitioner had his first dealings with Walter Seligman (hereinafter referred to as Seligman), who then owned 58 percent of the stock of Petroleum Products Co., in 1939 when the latter company contracted to sell crude oil from the Hospaw Oil Field in New Mexico to petitioner and his partner.

In 1940, petitioner and his partner purchases Seligman's interest in Petroleum Products Co. Petitioner subsequently acquired all of the stock in Petroleum Products Co. by purchase from his partner and the other stockholders in that company with the exception of Vernon King, who retained the stock he had acquired prior to 1940.

In June 1943, Petroleum Products Refining & Producing Co. was organized in New Mexico and succeeded to the interests of Petroleum Products Co. and two other corporations operating in the area.

Prior to November 4, 1955, the outstanding capital stock of Petroleum Products Refining & Producing Co. (hereinafter referred to as Petroleum Products) was owned as follows:

+--------------------------------------------------------+
                ¦                                               ¦Shares  ¦
                +-----------------------------------------------+--------¦
                ¦Ray McGlothlin                                 ¦6,747.7 ¦
                +-----------------------------------------------+--------¦
                ¦Massachusetts Mutual Life Ins. Co              ¦100.0   ¦
                +-----------------------------------------------+--------¦
                ¦Vernon King                                    ¦65.0    ¦
                +-----------------------------------------------+--------¦
                ¦Ray McGlothlin, Jr                             ¦73.0    ¦
                +-----------------------------------------------+--------¦
                ¦Ray McGlothlin, Jr., trustee for Hal McGlothlin¦73.0    ¦
                +-----------------------------------------------+--------¦
                ¦Jack McGlothlin                                ¦73.0    ¦
                +-----------------------------------------------+--------¦
                ¦Kay McGlothlin                                 ¦26.0    ¦
                +-----------------------------------------------+--------¦
                ¦Joyce McGlothlin                               ¦26.0    ¦
                +-----------------------------------------------+--------¦
                ¦Total                                          ¦7,183.7 ¦
                +--------------------------------------------------------+
                

In 1949, for the purpose of diversification and to preserve its capital from inflation, Petroleum Products purchased the D'hanis Ranch which consisted of 2,214 acres located in south Texas. Subsequent to 1949, Petroleum Products traded its interest in a feed business for the Blakely Ranch in south Texas and 100 acres in San Antonio, Tex. Thereafter, the 100 acres in San Antonio was traded for the Slator Ranch which contained 17,800 acres near Laredo, Tex. The size of the Blakely Ranch was subsequently increased by the purchase of adjacent acreage and became known as the Crystal City Ranch. Petroleum Products stocked these three properties and operated them as cattle ranches. Resident managers were employed to operate each ranch. During this period, petitioner's permanent home was in Abilene, Tex., except for brief periods when he lived in San Antonio and on the ranches.

In 1952, at the request of Seligman, petitioner became a member of the board of directors of Texas Calgary Co. (hereinafter referred to as Texas Calgary), a publicly held company. Petitioner served in this capacity for a couple of years. In 1953, Seligman approached petitioner with the general idea of merging Texas Calgary and Petroleum Products, but nothing came of the negotiations.

In 1955, Seligman, representing Texas Calgary, called on petitioner in San Antonio and resumed negotiations for the exchange of Petroleum Products stock for Texas Calgary stock. The negotiations for the exchange of stock was based upon a comparison of Texas Calgary's properties and those of Petroleum products, as well as their comparative incomes and future prospects.

Upon completion of the exchange, petitioner was to be employed as president of Texas Calgary at a salary of $25,000. As a condition of the exchange, Texas Calgary stock was to be registered on the American Stock Exchange.

The exchange of stock was predicated upon appraisals of the oil reserves, assets, liabilities, and net worth of each company. At that time, Texas Calgary owned oil properties in Canada, Texas, and Oklahoma. Petroleum Products owned an oil refinery at Luders, Tex., and the three ranches as well as oil properties in New Mexico and Montana.

The Texas Calgary directors did not want to acquire the refinery or the ranches owned by Petroleum Products. The refinery was purchased from Petroleum Products at its book value by a corporation formed by petitioner's interests in exchange for its promissory note. Petitioner was not financially able to purchase the ranches nor was he personally interested in going into the ranching business.

Seligman advised petitioner that the Texas Calgary directors did not want the ranch properties and that they questioned the $898,014.08 book value of those properties. Without a satisfactory solution, the deal would have fallen through. Petitioner stated to Seligman that the properties were worth at least $200,000 in excess of book value and agreed that he would guarantee that value. They agreed that if petitioner would guarantee the value of the ranch properties to be $1,098,414.14, then Texas Calgary would complete the exchange of stock.

It was intended that petitioner would sell the ranches as president of Texas Calgary, on behalf of the company. Petitioner hoped the ranches would be sold within 2 years for at least the full amount that he had guaranteed them to be worth. At the time of the exchange, he believed the ranches were worth the guaranteed amount and would be sold within 2 years, so that he would suffer no loss. On or about November 4, 1955, an agreement (hereinafter referred to as the agreement) to exchange all of the stock of Petroleum Products for 6,215,928 shares of Texas Calgary stock was executed.

Paragraph 10 of the agreement provided as follows:

Ray McGlothlin individually and personally guarantees that in the event that the three (3) ranch properties included in the assets of Petroleum Products Refining and Producing Company, with a present fair value of one million ninety-eight thousand four hundred fourteen ($1,098,414.14) dollars and fourteen cents, are not sold by January 15, 1958, for an amount not less than the present fair value, that the said Ray McGlothlin will personally guarantee that upon six (6) month's notice by the Board of Directors of Texas Calgary, Texas Calgary shall receive full payment for such ranches or such ranch properties as remain, said payment to be no less than the present fair value of the ranch properties. If the Board of Directors of Texas Calgary rejects a bona fide offer to purchase the aforesaid ranch properties for an amount not less than the present fair value of said properties, or in the event that the Board of Directors of Texas Calgary rejects a bona fide offer to purchase the aforesaid ranch properties for an amount less than the present fair value of the said properties, said Ray McGlothlin, having agreed to pay the difference between the present fair value and the offering price, then, and in either event, the said Ray McGlothlin is fully discharged from the obligation arising from the guarantee contained in this...